VS1 Cloud Blog
If you own or want to start a business, budgeting is its central nervous system. But this isn’t an easy exercise. Steve Jordan, senior manager at Wipfli in Rockford, Ill., tells us how to do it:
Article by: Larry Light
Guest post written by: Steve Jordan
Using a budget is a key component in driving your organization’s financial future, but many businesses wonder: “How do we start?” or “How can we make our current budget better?”
Because a good budget could have a great impact on your overall operations, here are10 tips to help your business build an effective one.
Tip 1: Understand What a Budget Really Is
A budget is not meant to manage every penny spent. It is simply a guide to assist you in making better spending decisions, and it can be an eye-opening tool to identify areas for improvement.
When creating a budget, it’s important to maintain the right mindset. If you harbor a negative attitude about budgeting from the outset, the chances of creating a good budget significantly diminish. Instead of seeing it as a hurdle, consider creating a budget a positive move that provides you with a helpful business tool.
There are also different types of budgets. Some companies find it beneficial to budget on the accrual basis to estimate net income, while other companies focus on budgeting for cash flow.
Some organizations have two budgets to track both of these key financial performance measures. Regardless of which budget type you choose, everyone in your organization needs to be on the same page when it comes to the budget’s goals.
Tip 2: Know Your Organization
It is important to understand the risks of your organization and its industry. For example, if you operate in an industry that is significantly seasonal in nature, you will likely need to break down an annual budget into a quarterly, or even monthly, approach.
Before diving into the creation of your budget, you should be aware of pending changes in regulations, such as overtime rules, health care changes and the new tax law. You should also compare your organization to industry standards using your CPA’s tools and resources. Obviously, your organization is not exactly like every other one in your industry, but if you can identify areas where your results vary significantly (and the reasons for those variations), you can make better decisions about spending.
Overall, it’s a good idea to identify the most substantial threats to productivity within your organization and their financial impact.
Tip 3: Build the Right Budgeting Team
“If you build it, it will come together.” Okay, not quite the same line Kevin Costner’s character took to heart in “Field of Dreams,” but it’s very important to build the right team to create your budget. It should not be created by one person. If certain groups of employees are going to be held accountable for the budget, then they should have some influence on its creation.
While we typically restrict budget creation to members of management, maybe it’s time to think outside of the box and involve other individuals who can bring fresh perspectives to the budgeting table. For example, a factory employee may be able to identify when equipment will need to be replaced or overhauled. And who better to predict when potential repairs to delivery vehicles might be necessary than those who drive the delivery vehicles every day?
Tip 4: Be Realistic
A budget isn’t truly effective if it’s designed toward a targeted number. Employees will likely scoff and dismiss unrealistic budgets as unattainable.
Rather, you should develop your budget based on past results and future projections. Analyze financial results from up to five years ago as a starting point. What are some costs that are fixed and inevitable? Those can be entered first. Then you can look at accounts or line items that have fluctuated more drastically over the years. What caused this fluctuation? Were there one-time expenses? Can these fluctuations be controlled? Using past information and adjusting for predicted variances helps provide a more concrete basis for establishing budget numbers.
Tip 5: Be Conservative
As part of your budget, you should factor in some level of the unknown. As I tell our staff during audit training, “You don’t know what you don’t know, but you know that you don’t know something.” In other words, there is always some unexpected element of a project. If we knew all of a project’s anticipated costs and factors, it wouldn’t be a project.
Should you have a line item in your budget for contingencies, or should you round up each individual line item to factor this in? It’s up to you how you factor in unknown elements.
Make sure you consider the need to plan for future years. Economic downturns are inevitable, so in a strong economic year you should not only create a balanced budget but also start building up a cushion for the anticipated rainy days.
Tip 6: Be Flexible
It’s okay to amend your budget during the year; in fact, it should be amended several times throughout it. Revisiting your budget is a very healthy exercise for your organization’s well-being. If you wait until the end of the year to compare your actual results to the budget, you will be way behind the curve.
If you find certain line items that are in danger of going over budget, look for other line items that are coming in below budget and borrow from those items to maintain the same bottom-line goal you started the year with.
Tip 7: Be Detailed
The more detailed your trial balance is, the more effective your budget will be. Now, there is a fine line here. Obviously, you don’t want to have a separate line item for each check you write, but the more detailed you can get, the better. And that starts with tracking expenses according to the way your chart of accounts is set up.
Is it time for a fresh look? Should some things be grouped together? Are some line items really housing several different types of measurable expenses? These are all questions you should answer when it comes to your trial balance.
For example, some organizations may be fine with a line item called “payroll.” But other organizations will want to break that down by division or employee position type. Similarly, instead of having a line item for “employee benefits,” it may be more beneficial to have a line item for each type of employee benefit (e.g., health insurance, retirement benefits, sick and vacation pay and tuition reimbursement).
When it comes time to analyze why some line items were out of whack compared to the budget, this can help ease the pain.
Tip 8: Be Aware of Financial Relationships
Sometimes you can’t change just one line item in your budget. It’s like going to the store and buying a flashlight. You have to pick up batteries, too, right?
As a result, sometimes you have to be careful changing one line item of your budget without analyzing that change’s effect on other line items. For example, if you find out that you are going to increase your workforce by 10%, instead of simply increasing the payroll line item by 10%, you will want to increase employee benefits, payroll taxes and other items directly related to payroll.
Similarly, if you think you can just bump up your bottom line by increasing sales by 10%, don’t forget to also increase variable costs related to sales (e.g., costs of goods sold, commissions, taxes and freight).
Tip 9: Utilize the Right Tools
Most accounting software has a built-in budgeting tool, so if you’re frustrated with your Excel budget, take a step back and check whether your current software has a tool you could utilize to assist.
This may lead to increased efficiency, since you can link your results to multiple prior years and analyze the current-year budget with a simple click of a button. Let your software work for you!
Tip 10: Share It
An organization’s budget shouldn’t be a secret. While there are instances when some financial information should be kept to a limited group, organizations will find that increasing who the budget is shared with will lead to greater transparency, increased feedback and beneficial communication.
Further, the budget-to-actual result could be used as an incentive for employees to increase their division’s productivity and limit spending. By using the budget as a tool, an organization could create a friendly competition between divisions and reward employees for results, feedback to help keep divisions under budget or both.
The more you can empower and engage your employees, the better off your business will be. Know your organization, build the right team and share your budget with the right people. Its potential impact as a tool can be widespread.